Hemi Group, LLC v. City of New York

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Argued November 3, 2009.

Authorship: Brian Goldman of Stanford Law School

Docket: 08-969

Issue: Whether city government meets the Racketeer Influenced and Corrupt Organizations Act standing requirement that a plaintiff be directly injured in its “business or property” by alleging non commercial injury resulting from non payment of taxes by non litigant third parties.

Contents

Briefs and Documents

Decision

REVERSED AND REMANDED in an opinion by Chief Justice Roberts, joined by Justices Scalia, Thomas, and Alito, and joined in part by Justice Ginsberg. Justices Breyer, Stevens, and Kennedy dissented. Justice Sotomayor took no part in the decision. (January 25, 2010)

Oral Argument

Transcript (November 3, 2009)

Merits Briefs

Amicus Briefs

Certiorari-Stage Documents

Opinion Recap

On January 25, New York City was handed a defeat in its effort to recoup thousands of dollars in unpaid tobacco taxes when the Court ruled, by a vote of five to three, that the City could not use the Racketeer Influence and Corrupt Organizations Act (RICO) to go after out-of-state on-line cigarette retailers.

The case, Hemi Group, LLC v. City of New York, No. 08-969, arose out of the City’s effort to collect treble damages from out-of-state internet vendors who sell cigarettes to City residents at deep-discount prices – discounts made possible, the City contended, because the vendors do not collect the $4.25 per pack in state and local taxes that vendors within the City must include in their prices. The on-line vendors are not required to collect such taxes, however; rather, the individual purchasers are required to report and pay the taxes themselves. To assist states with enforcing the taxes, the federal Jenkins Act requires out-of-state vendors to report the names and addresses of purchasers to each customer’s home state. Hemi and other such vendors had committed mail and wire fraud, the City alleged, by failing to file the required reports and by advertising cigarettes to purchasers as “tax free.” Because that fraud deprived it of tax revenues, the City sought to recover the lost revenues by suing the vendors under RICO’s civil provision. After the district court dismissed the suit, the Second Circuit reinstated it. (Justice Sotomayor, who was a member of the panel that heard the case below, did not participate in its review at the Court.) The Court granted cert. in May 2009 and heard argument last November.

The Court reversed, holding that the City could not use RICO to seek damages from vendors, who were under no obligation to collect taxes in the first place. Writing for the Court, the Chief Justice described the case as one “about imposing [RICO] liability to substitute for or complement a governing body’s uncertain ability or desire to collect taxes directly from those who owe them”—the individual purchasers. (Justices Scalia, Thomas, and Alito joined the opinion in full; Justice Ginsburg, who concurred separately, joined only in limited part. Consequently, the thrust of the Chief Justice’s analysis commanded only a plurality of the Court.*)

The Court observed that Hemi presented two distinct challenges to the City’s RICO claim: First, it denied that lost tax revenues were cognizable as an injury to “business or property.” Second, Hemi disputed that the City’s asserted injury arose “by reason of” its allegedly fraudulent requirement, as RICO requires. Though the courts of appeals had been divided over the first question, and notwithstanding an amicus brief filed by twenty states urging recognition of the injury, the Court declined to reach the first question because it determined that the causation requirement had not been met.

RICO’s limited applicability to injuries incurred “by reason of” a predicate fraud imposed not only a “but for” requirement, the Chief Justice explained, but also a “proximate cause” one as well. Here, the City’s causal theory was too attenuated to satisfy this standard: Hemi’s alleged fraud was its failure to submit the required Jenkins Act reports to the State, which would have then had to pass on the information to the City. The City’s injury, meanwhile, arose most directly from purchasers who were legally obligated to pay the cigarette tax on their own, but failed to do so. Although receiving the purchasers’ information from Hemi (via the State) might have enabled the City to pursue non-paying purchasers for a tax assessment, there were too many links in that causal chain. Rejecting the City’s theory, the Chief Justice explained that it would “require[] that we extend RICO liability to situations where the defendant’s fraud on the third party (the State) has made it easier for a fourth party (the taxpayer) to cause harm to the plaintiff (the City).” Citing to the Court’s RICO precedents, the lead opinion noted that the kind of “direct relationship” required between the fraud and the injury was lacking here.

In her concurring opinion, Justice Ginsburg observed that the City could not compel Hemi, a New Mexico corporation, to collect City taxes. She viewed its RICO action as nothing more than an attempt “to overcome that disability,” and to broaden the “quite limited remedies” available under the Jenkins Act itself. Moreover, she noted, because the City had not even brought any claim under the Jenkins Act, it effectively conceded that no predicate fraud had been committed at all. Justice Ginsburg, however, declined to join the Chief Justice’s proximate-cause analysis.

Justice Breyer filed a dissenting opinion, joined by Justices Stevens and Kennedy. He viewed Hemi’s fraud as a clear proximate cause of the City’s injury. The City’s losses were foreseeable, he observed, and moreover Hemi intended them; indeed, Hemi’s entire competitive advantage stems from shielding customers from cigarette taxes. Citing to torts treatises, he noted that both foreseeable and intended consequences of an intentional act are “proximate” at common law. Taking issue with the Chief Justice’s suggestion that the intervening acts of third parties – purchasers not paying the tax they owed – made the harm attenuated here, Justice Breyer noted that “an intervening third-party act, even if criminal, does not cut a causal chain where the intervening act is foreseeable and the defendant’s conduct increases the risk of its occurrence.” And while Hemi’s alleged fraud deprived the State, rather than the City, of the required customer reports, Justice Breyer suggested that the State’s contractual obligation to pass the information on to the City made that step in the causal link insignificant. Moreover, the harm incurred through such inter-state tobacco tax arbitrage is “well within the set of risks that Congress sought to prevent” through the Jenkins Act, and liability generally flows when a defendant’s fraudulent misrepresentations cause the intended beneficiaries of a statute to suffer pecuniary loss. Justice Breyer distinguished the precedents upon which the Chief Justice relied, noting that they concerned unintended or unforeseeable harms.

Turning to the first question – whether the City’s loss of tax revenue is “business or property” under RICO, and thus a cognizable injury at all – Justice Breyer argued that it should be. While acknowledging the concern that such a result “would turn RICO into a tax collection statute,” he pointed to Justice Department guidelines demanding prosecutorial restraint to suggest that RICO would only be employed in large-scale cases of fraud, not for individual cases of tax collection. The Chief Justice, responding to this argument in a footnote, noted that such guidelines are “not only changeable, but have no applicability whatsoever to state or local governments.”

(* For apparently only the second time in its modern history, the Court issued an “opinion of the Court in part” that did not explicitly delineate – for example, by reference to Roman numeral-designated parts – which portions of the opinion commanded a majority and which were supported by only a plurality. See also Daniels v. United States, 532 U.S. 374 (2001). In this case, Justice Ginsburg joined “the Court’s opinion to the extent it is consistent with” her concurrence, but “[w]ithout subscribing to the broader range of the Court’s proximate cause analysis.”)

Oral Argument Recap

At oral argument in Hemi Group v. City of New York, the Court wrestled with the case’s two primary questions: First, do unassessed taxes fit within RICO’s definition of “property,” such that treble damages can be sought when a civil defendant commits a predicate act that deprives a local government of the ability to collect taxes? Second, were the defendant’s actions here – running an internet cigarette business that advertised products as “tax free” to customers in high tobacco tax jurisdictions, and then failing to comply with federal law requiring that sales be reported to purchasers’ states to facilitate tax collection – a proximate cause of the City’s loss?

On the first question – one that had divided the courts of appeals – counsel for Hemi Group, Randolph Barnhouse, encountered sharp resistance from the bench. Though he attempted to distinguish between the opportunity to collect taxes – an inchoate sovereign interest – and tax revenues themselves, the Court appeared to view this as a distinction without a difference. The Chief Justice, for example, noted that “a lawsuit with a potential recovery [is] regarded as property of an individual,” and Justice Ginsburg referred to Pasquantino v. United States, a 2005 case in which the Court held that Canada’s right to receive tax revenue was “property” within the meaning of the federal wire fraud statute. Barnhouse responded that RICO’s definition of “property” is narrower than in other criminal statutes. Moreover, he suggested that because the amount of taxes owed the City could not yet be calculated, no cognizable property interest existed. Justice Scalia, who brought the courtroom to laughter an impressive four times over the course of the hour, dismissed that point as a simple issue of damages, which the City would have to prove later at trial.

Leonard Koerner, arguing for the City, faced significant challenges of his own. Justice Breyer voiced concern over the potential repercussions of the City’s position: could California try to close its current budget deficit by using RICO to seek treble damages from “every corporation that files an income tax return and makes two false statements”? Koerner noted that he couldn’t “dispute [the] fact pattern” – a concession that seemed to alarm Justice Kennedy. Moreover, the Chief Justice and Justice Kennedy expressed concern that the City would be able to prosecute any mail-order company whose customers did not pay tax. But Koerner argued that, notwithstanding other possible local government uses of RICO, Congress had made clear its intent to place cigarette taxes within RICO’s reach by adding violations of the Cigarette Contraband Trafficking Act as predicate offenses under RICO. And in a variant on an “unclean hands” argument, Koerner observed that it is disingenuous for Hemi Group to argue that the lost taxes are not property because they were never assessed, when the City was prevented from assessing the taxes by the Group’s failure to provide the names of cigarette purchasers as required by law.

On the second question, Hemi Group’s challenge seemed to gain more traction. Barnhouse contended that any injury to the City was indirect, because individual purchasers’ decisions not to pay the use taxes they owed constituted an independent intervening force. Justices Alito, Breyer, and Ginsburg seemed skeptical that any causal link to Hemi Group was attenuated, given the Group’s heavy advertising of “tax free” cigarettes and the City’s inability to assess taxes without the sales reports the Group was required to provide. In his argument, Koerner picked up on this point, faulting Hemi Group for “leading the consumer to believe they didn’t have an obligation to pay.” Justice Scalia wasn’t so sure that customers were actually led astray by the website: “I’ve known a lot of New Yorkers, and not many of them are that gullible.” And the Chief Justice suggested that “[t]he injury is directly caused by the consumers who don’t pay the taxes.” Koerner acknowledged that, to prove causation, the City would have to show at trial that it could (and would) have actually collected taxes had it received the list of purchasers, but he expressed confidence the City could do so. He maintained that, because Hemi Group’s “entire business plan is based on not paying tax,” its fraudulent acts were a proximate cause of the City’s injury.

Because she was a member of the Second Circuit panel that issued the decision below, Justice Sotomayor did not participate in Tuesday’s argument. Should the Court divide evenly, the lower court opinion will be left undisturbed.

Argument Preview

This case presents the Court with an issue being watched closely by state and local governments nationwide: whether such governments may bring civil suits to recover non-commercial losses – such as uncollected taxes – under the Racketeer Influenced and Corrupt Organizations Act (RICO), which confers standing upon “any person injured in his business or property by reason of a violation of” RICO’s criminal prohibitions.

Petitioner Hemi Group operates websites offering cigarettes for sale “tax-free.” The company ships cigarettes from low-tax jurisdictions (such as tribal lands in New Mexico) to customers nationwide, including many in high-tax jurisdictions. New York City is one such high-tax jurisdiction; it (as well as New York State) imposes a tax on all cigarettes used or sold in the City. Taxes on cigarettes sold in the City are collected at the point of sale by vendors. By contrast, out-of-state vendors such as Hemi Group are not responsible for collecting local taxes; rather, customers who consume out-of-state purchases in the City are required to report and pay the taxes themselves. Because collecting such taxes is extremely difficult, and because different state tax rates have long been arbitraged through interstate sales, Congress passed the Jenkins Act in 1949 to facilitate tax collection by requiring out-of-state vendors to report purchases to each customer’s state.

This case began as one of four suits brought by the City in federal court seeking treble damages under RICO’s civil provision from online tobacco retailers – who, the City alleged, had schemed to defraud the City of tax revenues by failing to file the required Jenkins Act reports with the State. The City claimed, among other allegations, that the retailers committed predicate acts of mail and wire fraud by advertising to customers that their products were “tax-free” and falsely stating that the companies were not required to report sales to authorities in customers’ states. The retailers’ failure to submit the required reports, the City complained, caused it to suffer an injury in the form of millions of dollars in uncollected tax revenue.

The retailers countered that the City had not alleged an injury to “business or property,” as required by RICO; moreover, because it was their customers, not they, who were responsible for the taxes, any injury to the City was not proximately caused by their actions. The district court dismissed the suits on unrelated grounds, and the City appealed.

The Second Circuit consolidated the cases, vacated the judgments, and reinstated the RICO claims. It held both that lost taxes are a cognizable injury under RICO and that the injury flowed directly from the retailers’ actions. (Because she was a member of the Second Circuit panel that issued the decision below, Justice Sotomayor has presumably recused herself from the case; she did not participate in the Court’s recent decision granting a motion for leave to file an amicus brief in the case. This raises the possibility of an evenly divided vote at the Court, which would leave the decision below undisturbed.)

After many of its co-defendants had settled the City’s claims, Hemi Group petitioned the Court for review. It argued that certiorari was warranted because two circuits had held that losses suffered by a government in its sovereign (as opposed to commercial) capacity can be injuries to “business or property,” while two others had held that local governments could not bring suit under RICO for redress for such losses. The Court granted cert. on May 4 – three weeks prior to Justice Sotomayor’s nomination to the Court.

On the merits, Hemi Group advances two broad arguments. First, it argues that recognizing the City’s standing to sue under RICO would contravene the text and history of the statute. According to Hemi Group, “the sovereign interest in collecting taxes” is neither a “property right” nor a “business.” Hemi Group explains that a “sovereign interest” is not something that can be “owned or possessed” by the injured party, which is RICO’s definition of “property.” Because an out-of-state vendor does not itself owe any taxes, the City is merely alleging injury to its opportunity to collect taxes and thus lacks standing. Hemi Group supports this argument with case law interpreting the Clayton Antitrust Act, which served as a model for RICO when Congress wrote it in 1970 and contains the same standing requirement as RICO. By 1970, courts had held that governments lacked standing under the Clayton Act to bring claims for damage to “sovereign interests,” as opposed to governmental commercial interests. Hemi Group argues that this same restrictive interpretation should apply here, especially given the Court’s frequent reference to antitrust precedents in construing RICO.

Second, Hemi Group contends that even if the City’s injury were cognizable, it is an indirect injury, because Jenkins Act reports were due to the State only (not the City), and taxes would have been collected from customers (rather than the company). Had the State not shared the reports with the City, or had the City failed to collect from customers it assessed, the City would have been “injured” notwithstanding Hemi Group’s actions. More generally, Hemi Group argues, injuries suffered by governments in their sovereign capacity are always indirect. The City’s claim thus fails to satisfy the proximate-cause requirement developed in RICO case law.

In its brief, the City counters that its “right to its lost cigarette excise tax revenues is ‘property’ and a valuable legal entitlement under” RICO, just as excise taxes have been found to be under the federal wire fraud statute. The City distinguishes between sovereign interests such as regulation enforcement, which may not be “property,” and “proprietary interests” such as tax revenue and the ability to collect it, which are. The City also dismisses Clayton Act interpretations as inapposite, arguing that the antitrust laws concerned a much narrower swath of market activity affecting competition, whereas RICO’s broader scope encompasses many more types of injury. Moreover, in enacting RICO Congress included a mandate that it be liberally construed precisely to ensure that new and complex criminal enterprises such as Hemi Group’s could be redressed. Counting tax revenue as “property” would further RICO’s purposes, and allowing the City to prosecute Hemi Group would serve the interests of the Jenkins Act and later enactments designed to combat cigarette tax evasion.

As to causation, the City argues that Hemi Group’s failure to comply with its Jenkins Act obligations directly deprived the City of the opportunity to collect taxes from customers. It is of no consequence that the required reports would have been given to the State (and thus the State, not the City, was being defrauded): because the State would have shared that information with the City pursuant to a longstanding joint agreement, the City’s injury flows directly from Hemi Group’s fraud. And it is similarly irrelevant that the State would also have a claim of direct injury to its own ability to collect taxes, as that would be an independent claim rather than a claim from which the City’s would derive. Finally, although customers themselves shared partial blame for failing to report their purchases, Hemi Group’s fraudulent misrepresentations to both the State (in failing to report) and customers (in advertising “tax-free,” unreported sales) made the company a sufficiently “substantial factor in the sequence of events that caused the loss” to meet RICO’s causation requirements.

Hemi Group uses its reply brief to assail the City’s “ad hominem” attacks against the company and largely to rehash the arguments presented in its opening brief. It discounts the City’s reliance on RICO’s liberal construction mandate; in its view, that reliance cannot overcome the weight of the statutory text and history, which cut the other way. And although the company acknowledges that tax revenues themselves are undoubtedly property, the “‘opportunity’ to collect taxes” is something quite distinct. While a tax assessment might be a cognizable property interest, no assessment was made here. And “[u]ntil assessment, the sovereign interest is inchoate,” and therefore cannot be injured for purposes of RICO. Finally, Hemi Group pushes harder on its indirect-injury argument, noting that the City’s poor record of use-tax collection seriously undermines its argument that it could have collected all of the taxes it now claims as damages.

Twenty states joined an amicus brief in support of the City, arguing that state and local governments depend on civil RICO suits as a critical, albeit limited, tool to remedy tax evasion and fight public corruption. Additionally, the Campaign for Tobacco-Free Kids filed a brief that sheds further light on Congress’s efforts to penalize “large-scale cigarette bootlegging,” including a 1978 tobacco-specific enactment that amended RICO – an amendment, the organization joins the City in arguing, which suggests that Congress intended suits such as the City’s to proceed under RICO.

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